Can European Equities Regain Footing amid Global Adversity?

European equities have started 2025 on a positive note. Several factors could help the market overcome challenging conditions.

Investors in Europe have had few reasons for optimism in recent years, with equity gains heavily concentrated in the US—and among the Magnificent Seven in particular. Now, with valuations looking more attractive, we think European equities warrant a closer look.

It’s still early in the year, but European stocks are showing potential. The MSCI Europe Index has advanced by 8.2% through March 14  in euro terms, outperforming the S&P 500 thus far in 2025. Can European markets gain more ground in a challenging environment? That depends in part on whether US President Donald Trump’s tariff actions turn into an all-out global trade war. Tariffs notwithstanding, we believe investors in European stocks have reason for optimism.

Compelling Valuations Aren’t the Only Story

The primary argument in favor of Europe has often centered on valuations. No doubt, Europe appears attractively valued. By the end of February, the MSCI Europe Index traded at a 35% discount to the S&P 500—much deeper than its long-term average (Display). There are of course structural differences between the two markets. The US has far greater exposure to the technology sector, while Europe is generally more exposed to banks and commodities. Even accounting for those discrepancies, Europe trades at a 20% discount to the US on a like-for-like basis.

The problem with valuation-based arguments is that a catalyst is needed to close the gap, and for some time now, this has been lacking in Europe. One catalyst could be improving technicals. January 2025 saw the first month of inflows into European equities since the beginning of the Russia-Ukraine war. And perhaps more markedly, we saw the second-largest positive shift in sentiment to European equities in history, according to a recent Bank of America fund manager survey.

Could this lead to more inflows? Investors are generally overweight US equities, and Europe’s equity allocation in global funds has fallen to 5% by the end of 2024 (Display), compared with the region’s benchmark weight of 13% in the MSCI ACWI Index. So even a small shift back toward Europe could support further gains.

Earnings Have Exceeded Expectations

The macro data is also supportive. Cyclical data is holding up better than expected, and GDP growth could benefit from plans to boost defense spending across Europe. Earnings also look solid, with the average European company beating consensus expectations by 3% during fourth-quarter earnings season. European companies are also seeing more earnings upgrades than their US peers, with earnings growth expected to accelerate through 2025.

Even if the economic data were weaker, GDP growth doesn’t necessarily translate to earnings. In fact, eurozone real GDP growth has only averaged 1% annually over the past five years, but company earnings in the MSCI Europe Index have approached 10% (Display, above).

In addition, a weaker euro is a welcome tailwind for many European companies—especially those with international revenue exposure. Meanwhile, increasingly muted inflation means the path to further interest-rate cuts looks clearer in the eurozone than in the US. Indeed, on March 6, the European Central Bank cut the region’s benchmark rate by a quarter point to 2.5%. 

Russia-Ukraine War Affects Investor Sentiment 

Another big wildcard for European sentiment is a possible ceasefire in Ukraine. Since the start of the Russia-Ukraine war, European equities have suffered cumulative outflows of $150 billion, according to Citigroup. The war has also had a profound negative impact on investor sentiment, which affects flows, valuations and the energy markets; energy costs are still 75% above pre-war levels. This, in turn, contributed to inflationary pressures, weaker consumer confidence and poor economic growth.

To be sure, the realignment of geopolitics around Trump’s foreign-policy agenda makes it hard to predict how the next stage of the Russia-Ukraine war might play out. Progress toward a ceasefire wouldn’t immediately solve Europe’s problems—some of which appear structural. Still, we think it would certainly be a step in the right direction toward improving the macroeconomic backdrop. 

Tariffs Won’t Affect All European Companies Equally

That said, the macro debates that tend to dominate news headlines are less significant for equity investors who deploy a long-term, bottom-up approach to investing in quality companies. Firms with market-leading products or services, strong management teams, competitive pricing power and established barriers to entry generally have more control over their own destiny and are not at the behest of the macro environment or politicians.

Despite lackluster European economic growth over the past five years, there are still compelling growth stories to be found. Many market-leading European companies benefit from differentiated sources of demand, often with most of their revenues outside Europe.

This is perfectly illustrated through the US tariff debate, which is more nuanced than how it’s often portrayed.

European companies, much like those in other regions, face a raft of new challenges from Trump administration policies. Steel and aluminum exporters will be directly affected by US tariffs of 25%, which have triggered countermeasures from the European Union.

On average, European firms generate 20% of their sales from the US. But only about one-quarter of that amount is from exports to the US. The rest comprises products and services made in the US that may not be subject to tariffs. Autos, medical technology and industrial components produced stateside are just a few examples.

While many companies would suffer from tariffs, the effects will vary widely, and some European businesses will be capable of surmounting new hurdles. For European equity investors, the challenge is to identify businesses that can best compete amid these challenges. Companies with strong pricing power and US operations will be much less vulnerable to potential tariffs. These firms may even be able to turn trade wars into increased market share.

If market conditions remain choppy, companies with strong product lines, wide competitive moats and quality business models can still shine. By using clear criteria for sourcing high-quality growth businesses, investors can identify companies that are more likely to overcome policy-driven obstacles and defy any lingering pessimism over the plight of European markets.